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Valuation of Natural Gas in Salt Cavern Storage Facilities Michael Bond Hank Grant PhD Slide 2 Natural Gas Consumption 1997-2007: 23 Trillion Cubic Feet/Year 1997-2007: 23 Trillion Cubic Feet/Year All US Production All US Production 4.6 Tcf Imported 4.6 Tcf Imported Pipeline (Canada & Mexico) Pipeline (Canada & Mexico) Liquid Natural Gas Liquid Natural Gas Slide 3 Natural Gas Use Slide 4 Necessity for Storage Other commodities Other commodities production is seasonal production is seasonal consumption is relatively level consumption is relatively level Natural Gas Natural Gas production is relatively level production is relatively level Short term Short term consumption is seasonal consumption is seasonal Residential Winter Residential Winter Power generation Summer (lesser) Power generation Summer (lesser) Investment opportunity Investment opportunity Slide 5 Seasonality of Gas Prices Slide 6 Gas In Storage Slide 7 Types of Gas Storage Above Ground Above Ground Liquid NG Liquid NG Containers Containers Local distributors Local distributors To meet local daytime peak usage To meet local daytime peak usage Slide 8 Types of Gas Storage Underground Underground Depleted gas reservoir Depleted gas reservoir Aquifer Aquifer Salt Cavern Salt Cavern *Mines *Mines *Natural caves/caverns *Natural caves/caverns * Minor usage * Minor usage Slide 9 Underground Storage Facilities Slide 10 Depleted Reservoir Most common Most common Depleted gas field Depleted gas field 1 Turnover/year 1 Turnover/year 24-36 months construction time 24-36 months construction time Structural considerations Structural considerations Any area with natural gas field Any area with natural gas field Slide 11 Aquifer Very high cushion gas requirement Very high cushion gas requirement irrecoverable irrecoverable 1 turnover/year 1 turnover/year Wherever aquifers exist Wherever aquifers exist Most expensive Most expensive Slide 12 Salt Cavern Constructed in salt dome Constructed in salt dome Higher Pressure Higher Pressure Least cushion gas Least cushion gas Turnover 4-5/year Turnover 4-5/year Longest to construct 36-48 months Longest to construct 36-48 months Gulf Coast, Great Lakes area Gulf Coast, Great Lakes area Slide 13 Salt Dome Cavern Slide 14 The Lille Torup gas storage facility has seven gigantic cavities (200- 300m by 50-75m) called caverns at a depth of 1.2 and 1.5 km in a large subterranean salt dome. Slide 15 Salt Deposits Slide 16 Compare Salt Cavern with Reservoir Type Examine operational differences Examine operational differences Is there a financial advantage? Is there a financial advantage? Slide 17 Approach Set initial parameters Set initial parameters Gas on hand Gas on hand Cash on hand Cash on hand For a period of 1 year For a period of 1 year Generate daily decision to buy, hold or sell Generate daily decision to buy, hold or sell Stochastic Stochastic Estimate future decisions Estimate future decisions Adjust if necessary Adjust if necessary Gas cannot exceed capacity Gas cannot exceed capacity Cannot sell gas not on hand Cannot sell gas not on hand Calculate change in gas and cash Calculate change in gas and cash Slide 18 Approach Create simulation with AWESIM Create simulation with AWESIM Evaluate results Evaluate results Slide 19 Model - Assumptions No holding costs No holding costs No injecting/withdrawal costs No injecting/withdrawal costs Static injection/withdrawal rates Static injection/withdrawal rates Monthly Price changes Monthly Price changes Slide 20 Model - Parameters Injection time 45 days (V45) Injection time 45 days (V45) Volume=V Volume=V Inject rate= R Inject rate= R Price = P Price = P Cost = C Cost = C Injection time 180 days (V180) Injection time 180 days (V180) Volume = 4V Volume = 4V Inject Rate = R/4 Inject Rate = R/4 Slide 21 Gas prices Slide 22 Performance Trivial pricing Trivial pricing Same transactions Same transactions Equal profit Equal profit Slide 23 Simple Single Peak Pattern Most common pattern Most common pattern Winter demand Winter demand V180- 6 months inj then 6 months w/d V180- 6 months inj then 6 months w/d Same profit Same profit Slide 24 Various Patterns Same results Same results Slide 25 Initial results Given equal states Given equal states Transaction activity (volume) Transaction activity (volume) Knowledge of future prices Knowledge of future prices Equal profits Equal profits Intuitive Intuitive Slide 26 Future Prices Difficult to predict the future Difficult to predict the future Forecast Methods Forecast Methods Based on historical Based on historical Random Variation Random Variation Mean Reverting Mean Reverting Mean Reverting with Spikes Mean Reverting with Spikes Slide 27 Real Options Theory Consider Financial Instruments Consider Financial Instruments Options to buy or sell stock Options to buy or sell stock Potential Business opportunities = Potential Business opportunities = Buy Options Buy Options Ex: Undeveloped Gas Reserve Ex: Undeveloped Gas Reserve Commodities in storage = Commodities in storage = Buy or Call Options Buy or Call Options Slide 28 Black-Scholes - Evaluating options Current Cost (Spot) Current Cost (Spot) Future Price(Strike) Future Price(Strike) Volatility of prices Volatility of prices Risk free interest rate (US T-Bills) Risk free interest rate (US T-Bills) Time (years) Time (years) Normal Distribution Normal Distribution Slide 29 V180 Injection Pattern Injection season 180 days Injection season 180 days Low demand Low demand Lower prices Lower prices Summer Summer Withdrawal Season Withdrawal Season Higher Residential Demand Higher Residential Demand Higher prices Higher prices Winter Winter Slide 30 Sensitivity to Volatility Shorter cycle time Shorter cycle time Take advantage of short-term price spikes Take advantage of short-term price spikes Slide 31 V180 vs V45 V45 cf/y greater V45 cf/y greater V45 cost per injected cf lower V45 cost per injected cf lower Slide 32 Summary Continuing to investigate Continuing to investigate Quantify Salt Cavern advantage Quantify Salt Cavern advantage Single Cavern Facility vs Multi-Cavern Single Cavern Facility vs Multi-Cavern